Obama to Propose Limits on Risks Taken by Banks

Great Debates
1

According to the NY Times, the Obama administration is going to propose legislation that will limit bank size and prohibit commercial banks from proprietary trading. Per the article, “Only a handful of large banks would be the targets of the proposal, among them Citigroup, Bank of America, JPMorgan Chase and Wells Fargo. Goldman Sachs, the Wall Street trading house, became a commercial bank during this latest crisis, and it would presumably have to give up that status.”

Daniel Gross seems to have anticipated the impending showdown with his January 15 column explaining why the financial industry has a long history of being Really Really Wrong about good financial regulation.

I’m in favor of Glass-Steagal 2.0. But I cannot imagine that the “handful of large banks” listed above will take this lying down. Is there even a chance that this kind of legislation will pass? I worry that the health care debate (in particular) has absorbed a lot of the collective energy and fears incited by the crash of '08, leaving very little attention for the actual guilty parties/practices. What say you?

2

It will be another failed proposal on his part. If he wants to regulate bad banking practices he should look to his own house first with Fannie Mae.

3

If the people saying Obama needs to change his tactics and become a vocal leader are right, this seems like a great political opportunity to deflect from the health care setback. With some financials posting billions in profit while the economy is still in the tank, he can really ride the populist wave and shame the people in Congress who would stand in the way. He would be smart to use his “transparent” shtick and shine a light on the people that are obviously bought by the industry.

4

You mean, just on political-pragmatism grounds because that’s the only banking reform you think could get passed?

But is that where we really should be directing efforts at banking regulation reform? Is anybody seriously arguing that recklessness in the deregulated banking industry wasn’t a major contributor to the recent crisis?

You would think that all those folks who bitched and moaned so loudly about the bailouts to the banking industry would welcome proposals to provide a little more adult supervision so we don’t have to go through that again.

5

The major problem with the banking crisis was a failure of government regulation of an instrument they brought into being. There is nothing wrong with the concept of derivatives but they were under-funded from the beginning. It’s no different than Fanny Mae underwriting the purchase of bad loans. The combination of the 2 was a financial tsunami in the making.

Financial regulation should not involve punitive damages for wealth. That is not the government’s purpose. When I see legislation that singles out one business over another I question the legitimacy of it.

6

You mean derivatives, right? Yes, I agree. However, the financial industry bears at least as much of the blame for the havoc wreaked by under-regulated derivatives trading, since they eagerly embraced the new instrument and strongly resisted suggestions to regulate it. They don’t get to duck their share of the blame now by saying “But it’s all Nanny Government’s fault for letting us play with dangerous toys, so you can’t punish us! Waaaaah, it’s not faaaair!!”

Sounds like a nice libertarian soundbite but I’m not seeing how it really applies to Volcker’s proposed banking regulations. Their chief feature seems to be the proprietary trading ban, which AFAICT doesn’t “involve punitive damages for wealth”.

7

Unfortunately, the big culprits like Lehman Bros, Bear Stearns, JP Morgan, et al, are traditional investment firms, not banks, and wouldn’t be affected by this Volker plan. I’m 100% behind Obama on this one, but it doesn’t go nearly far enough. Fannie and Freddie were at least 50% of the problem, and they need to be seriously reigned in.

8

Ignoring mortgages and derivatives for the moment, people need a safe and secure banking system: they need to be able to put their money into a bank account, get a low or zero interest rate on it, and be sure that they can get their money back out when they need it. That means two things:
(1) the government guaranteeing those deposits; and
(2) the government regulating the banks so that it isn’t left holding the baby when the banks’ risky behaviour doesn’t pay off, and the banks go insolvent.

If those bankers want to take risks with other people’s money, then:
(1) they should stop calling themselves “banks”, and call themselves something like “investment brokers”; and
(2) since their customers are carrying part of the risk, give them part of the rewards, i.e., higher returns when the risky mortgage derivatives are paying off.

If the government doesn’t regulate the banks’ risk taking, then we’ll see a replay of what happened at the start of the recession: the customers or the government carrying the risk, and the banks (executives and stockholders) taking the rewards.

9

Meh, prop desks will be spun off as independent HFs. Not really as big a deal as it’s being potrayed as imo.

10

It’s not an actively bad law, but it’s likely just to shift financial actors around and swap some labels, rather than actually addressing a problem. That said, it’s probably clever from a political point of view - the entity called “Goldman Sachs” will either shrink or lose money (though its constituents will be fine), and populists can crow without causing real damage…

11

No disagreement.

I have nothing against regulating any conflicts between public and private funds. The idea of removing a financial instrument that is predominant found in larger institutions sets of alarms of economic engineering.

12

Ha. The devil is in the details. Let’s see what gets passed through the Senate after the lobbyists get busy. How will it affect firms with foreign operations, they can just do their brokerage stuff overseas. How will it affect Goldman, they’re a depositary too now. What about non-backstopped firms underwriting the operations of the newly regulated firms? Things go bad and the bad debt just shows up there, the government would still have to bail the system out. It’s a panic move after getting Coakleyed the other day and it’ll end up being about as effective as the derivatives legislation is, if it even gets that far.

And for people upthread, exactly how many bad mortgages did Fannie and Freddie write? And during the bubble period when they and all the other firms took their bad debt on which political party was in charge of regulating them?

13

That’s true, but the Volcker proposals are something to be “include[d …] in whatever bill dealing with financial regulation finally emerges from Congress”, not the sum of those bills. So it’s very possible that those bills will consist mostly of some good old fashioned soak-the-fat-cat-rich-bankers populism.

I am very much in favor of the Volcker proposals, I believe. [My father - a Very Smart Guy and a guy who has made a lot of money investing in obscure stock market instruments over the years - is adamant that the chief villian in the financial meltdown is Allen Greenspan, who used his considerable prestige to convince Congress to repeal the Glass-Steagall Act.] The question is what else comes along with it.

What’s certainly outragious is for anyone to create a situation in which taxpayers are going to be required to bail them out if they fail. And if there’s truly such a thing as a bank becoming “too big to fail” then the banks have to either barred from becoming too big or regulated to the point where they can’t fail.

14

Apparently, the Democrats resisted regulation of these entities at the time, in the interest of furthering their mission of helping low income people buy homes. You can look it up.

15

The GOP controlled the various finance committees during the bubble period. So what difference did it make what the Democrats on them wanted? And every party for forty years has supported increased home ownership.

Posted 1/20/2004 1:31 AM

Bush seeks to increase minority homeownership

By Thomas A. Fogarty, USA TODAY
In a bid to boost minority homeownership, President Bush will ask Congress for authority to eliminate the down-payment requirement for Federal Housing Administration loans.
In announcing the plan Monday at a home builders show in Las Vegas, Federal Housing Commissioner John Weicher called the proposal the “most significant FHA initiative in more than a decade.” It would lead to 150,000 first-time owners annually, he said.
Nothing-down options are available on the private mortgage market, but, in general, they require the borrower to have pristine credit. Bush’s proposed change would extend the nothing-down option to borrowers with blemished credit.
The FHA isn’t a direct lender, but guarantees loan payments for mortgages on moderately priced owner-occupied property. The FHA guarantee now permits private lenders to finance as much as 97% of the purchase price of a home for millions of low- and middle-income borrowers.
In the proposal soon to be delivered to Congress, Bush would allow the FHA to guarantee loans for the full purchase price of the home, plus down-payment costs. As a practical matter, the FHA would guarantee mortgages as high as 103% of the value of the underlying property.

http://www.usatoday.com/money/perfi/housing/2004-01-20-fha_x.htm

Mortgage lending went wild during the bubble. Wall Street firms went crazy to get their hands on mortgage paper and in one year Fannie lost over half of her market share as mortgage originators ramped up the lending and sold it direct to Wall Street.

16

And Bush called for reform of Fannie Mae from day one.

17

So for the six years that the Republicans held sway why did nothing happen? This type of thing is just as disingenuous as only complaining about excessive debt when a Democrat is in power or only protesting excessive security measures when a Republican is in power.

Bottom line is that the biggest factor in the mortgage bubble was not FM qualifying mortgages, but rather the sub prime mortgages that they didn’t buy into until late in the bubble.

18

If Fannie May had ceased to exist on January 21st 2001 then there’d have just been one less competitor for all the bad mortgages that were issued by unregulated originators. Freddie too. The mortgages would all still have been written and sold off to be turned into securities. And how come all those mortgages were allowed to be written? In a cunning fox/henhouse strategic move Bush appointed a bunch of longtime bank lobbyists, people who’d spent their entire careers attempting to get financial regulation scrapped, to run the varioous federal regulators’ offices. In 2003 they held a press conference where they actually took a chainsaw and tree shears to a stack of mortgage regulations :

http://www.papolicyblog.com/pablog/chainsaw.jpg

(I just grabbed that from google images, don’t know what the blog it came from is like.)

And when it was obvious that bad lending had gone rampant, Bush used the same regulators to stop the AGs of every state in America from filing charges to stop bad lending. Here’s the former NY AG to explain :

Several years ago, state attorneys general and others involved in consumer protection began to notice a marked increase in a range of predatory lending practices by mortgage lenders. Some were misrepresenting the terms of loans, making loans without regard to consumers’ ability to repay, making loans with deceptive “teaser” rates that later ballooned astronomically, packing loans with undisclosed charges and fees, or even paying illegal kickbacks. These and other practices, we noticed, were having a devastating effect on home buyers. In addition, the widespread nature of these practices, if left unchecked, threatened our financial markets.
Even though predatory lending was becoming a national problem, the Bush administration looked the other way and did nothing to protect American homeowners. In fact, the government chose instead to align itself with the banks that were victimizing consumers.
Predatory lending was widely understood to present a looming national crisis. This threat was so clear that as New York attorney general, I joined with colleagues in the other 49 states in attempting to fill the void left by the federal government. Individually, and together, state attorneys general of both parties brought litigation or entered into settlements with many subprime lenders that were engaged in predatory lending practices. Several state legislatures, including New York’s, enacted laws aimed at curbing such practices.
What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no.
Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.
Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.
In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government’s actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.
But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation…

http://www.washingtonpost.com/wp-dyn/content/article/2008/02/13/AR2008021302783.html

Fand F were two private companies losing vast chunks of their market share to Wall Street firms who were turning these bad loans into toxic securities. Yeah they were government backed and yeah they bought a huge amount of non-subprime regular loans that went bad (they’ve always bought a huge chunk of total mortgages issued), but all the loans they bought went bad due to the bubble and consequent recession, not because they did anything bad or were government-backed or the Democrats allowed them to do it or it was all Jimmy Carter’s fault. That’s all just dissembling by the people who were actually to blame for the meltdown.

19

The banks immediately sold them off. Therefore it did not matter if the mortgages were good or bad. it was not their problem. They dumped them on the rest of the world. For banks, it was a race to the bottom. There was no force to keep risk under control. There was a lot of pressure to raise it.

20

The risk was theoretically mitigated by derivatives except the derivatives weren’t properly regulated so the end result was a bad loan, backed up by worthless paper in search of a housing bubble. It was the perfect storm fed by low interest rates.

Getting back to the topic, I would like to see Volker’s primer on what he’s proposing.